Daily Development for Wednesday, July 28, 2004
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin Kansas City, Missouri dirt@umkc.edu

After I wrote this, I asked my Vermont contact if what I say here about current Vermont law is accurate. He answered (unqualified opinion, of course) “probably.” Ed.)

MORTGAGES; ASSIGNMENTS OF RENTS: “Overbearing, abusive and insensitive” behavior of mortgagee in dealing with defaulted mortgagor’s tenant, at time when tenant is considering extension of lease, constitutes tortious interference even when mortgagee has the right to collect the rents, but does not constitute breach of the implied covenant of good faith and fair dealing.

Von Turkovich v. APC Capital Partners, LLC, 259 F.S. 2d 314 (D. Vt. 2003)

This trial court opinion is colorful enough and different enough to warrant comment, although normally DIRT DD’s involve only appellate decisions. Borrowers owned a number of commercial properties from which they derived rental income. A group of the properties was secured by a single mortgage, and was in default. Mortgagee’s rights included an express assignment of rents.

A major tenant for borrowers had leased property in one of the mortgaged buildings for some time and was in negotiations to expand its occupied space and to extend its lease for an additional four years. The deal involved the tenant, at its expense, making certain renovations to the building, but the parties were so confident of a deal, and the relationship between them so cordial, that the tenant had undertaken to make the renovations at its own expense even before the final papers had been signed. It’s not clear whether this lease would have resolved borrower’s financial difficulties on the mortgage, but of course it does appear that it would have hurt.

Enter the villain of the piece (at least according to the court’s opinion - APC.

APC was a company apparently formed by a former senior Paul, Weiss associate with some background in real estate. It specialized in acquiring and attempting to derive a profit from troubled real estate loans (what some might call “bottom feeding.”) Borrowers had the misfortune (or bad judgment) to sink into default on their mortgage and the mortgagee sold its interest in the loan to APC.

APC and the borrowers engaged in six months of bitter negotiations, including constant threats of foreclosure and an aborted filing of judicial foreclosure, resulting ultimately in borrower refinancing the property, leaving APC with a profit of $200,000. The problem in the case stems from APC’s tactics during this negotiation period. The court found, in part based upon testimony of APC’s principle himself, that a APC was alternately threatening and cajoling the tenants, demanding that they pay rent directly to APC, and that a purpose of this tactic was to bring pressure to bear on borrowers so that they would accede to a refinancing on terms favorable to APC. APC’s conduct, stripped of the dozens of pejorative adjectives added by the court, was as follows:

When APC first contacted the tenant in question here, it was the owner of the loan and the borrower was clearly in default. It had not yet filed for foreclosure. It demanded that the tenant pay rent directly to APC. The court suggests that the demand for rent by the mortgagee was beyond its rights. [Veteran Vermont lawyers that the editor contacted assure him that the court was wrong on this point - a mortgagee with an assignment can activate it at any time following default and can do so by notice to the tenant.]

APC’s principle also told the tenant that it would have to discontinue the construction it was undertaken as it was outside of its authority under the existing lease and hadn’t signed a new lease. Further, the principle alleged that the work was not up to code and would have to be replaced anyway. Based upon assurances from borrower, tenant continued with the work for a time, but when tenant was served with a foreclosure complaint [thus indicating that the tenant’s lease would be terminated upon foreclosure], tenant stopped the work. The court indicates that APC had no right to assert any rights versus tenant with respect to the work on the building. [Again, veteran Vermont lawyers assure the editor that Vermont is still a title theory state, and that the mortgagee had every right to assess a possessory interest in the property upon default. This prohibition of work outside of that permitted by the lease would appear to the editor to be a possessory act, rendering APC a mortga gee in possession - but the court doesn’t go there.]

APC then discussed with tenant a nondisturbance agreement, protecting it in the event of foreclosure, but in doing so, according to tenant, APC demanded a number of changes in the proposed new lease that tenant had negotiated with borrower. Most important among these was deletion of the right of either party to have an “easy out” from the lease - a termination right with certain conditions upon 90 days notice. Also APC demanded that tenant supply financial information as a predicate to any negotiation of a new lease, which tenant refused to do.
Tenant ultimately demanded that APC deal only with tenant’s counsel, but even thereafter APC contacted tenant on a number of occasions. Although ultimately it dismissed the foreclosure complaint against everyone and agreed to send a draft of a nondisturbance agreement, it never produced one.

Tenant testified that it commenced looking for new space specifically and directly because of a concern that the APC principle might ultimately be his new landlord in that space. It ceased considering extending its lease in the Borrower’s space.

The court found that the behavior of APC as described above was outside of its legal rights and beyond the ordinary conduct of lawyers representing Vermont mortgagees (the source of this conclusion was the testimony of Borrower - certainly a neutral witness.) With respect to the legality of the demand for rents, the court commented that tenant”was not a party to the assignment of rents agreement . . . and its lease did not include such provisions.” [The legal significance accorded to these facts by the court appears to go beyond the common law of Vermont or any other state.] The acts that went “beyond the pale” of other Vermont lawyers [remember that APC was not acting as a lawyer, but as a principle] were found unreasonable because “lenders do not typically require tenants to renegotiate leases; to provide, absent a lease requirement, financial information; or to waive claims against the landlord in order to obtain a non-disturbance agreement.” {Remember that tenant’s lease was ending and the discussions dealt primarily with the terms of the new, as yet unsigned, lease. Part performance doctrine would not be relevant as the court found that the parties had not yet actually agreed on the new lease.]

Ultimately, as stated, Borrower refinanced out APC, but by then tenant had acquired another building by purchase. When it finally vacated Borrower’s space, Borrower had about a ten month vacancy and ultimately relet the property for terms not nearly as favorable to Borrower as tenant’s lease had been.

On the above facts, the court found that APC was guilty of tortious interference with contractual relations but was not guilty of a breach of the implied contract duty of good faith and fair dealing. Although the court admitted that the negotiations between a defaulted borrower and its mortgagee are not normally a “tea party,” the court concluded that the apparent purpose of APC’s interraction with the tenant was to bring about a threat to the continuance of the tenant’s presence on the premises, a threat that APC hoped [according to the court] would bring Borrower to its knees on the refinancing negotiation.
The court concluded that APC should have known, based upon the principle’s experience that his conduct was “substantially certain” to chase away the tenant, to the financial disadvantage of the landlord. Thus, APC was liable for tortious interference even if the principle did not have the actual intent of chasing the tenant away.

The court commented that the relationship of the Borrower and its tenant should be taken into account. They had had a long-term landlord/tenant relationship and were negotiating an expansion and four year extension. But the court seems to be of the view that APC’s actions interfered with the existing relationship, since the tenant had no obligation to provide financial information under that the then existing lease. [The court ignores the fact that the court itself indicates that the financial information was requested in connection with a new non-disturbance agreement that apparently would carry forward into the period of the new lease.]

Inexplicably, given all the adjectives that the court heaped upon APC in the tortious infringement action, (“troubling,” “obnoxious,” “misleading,” “threatening,” “threatening,” “harassing,” - and all of this in three successive sentences,), the court concluded that Borrowers did not make out a case that APC was guilty of breach of the implied covenant of good faith and fair dealing. Since the editor is completely flummoxed at this about face, he will let the court’s words speak for themselves:
“Although improper, particularly on the part of an experience attorney, I do not find that [APC principle’s} behavior rises to the level of bad faith conduct violating the covenant of good faith and fair dealing. [He] was overbearing and obnoxious, and extremely insensitive. While he did not employ outright lies, he was misleading. He certainly went further than permitted under the loan agreements between APC and [Borrower,] and further than a lender should where there is no evidence of danger to the collateral, in his contacts with a tenant. However, his behavior was not so abusive or shocking that it violated ‘community standards of decency, fairness of reasonableness’ under the circumstances. The parties involved, including [tenant] were experienced business people. APC and [Borrower] were in the middle of contentious negotiations stemming from [Borrower’s default on loans totaling over a million dollars. In this context, tea party manners cannot be expected; impolite t
actics are likely to be employed to some degree. Under the circumstances of this case, [APC’s principles} conduct was not so outrageous as to have constituted bad faith conduct breaching the implied covenant of good faith and fair dealing.”

After all this, the damages award was relatively small, and likely wouldn’t have been any larger had there indeed been a breach of the implied covenant. Everyone probably spent more on Maalox and aspirin during the entire to do.

Comment 1: The court acknowledges that the Restatement of Torts contains an exception to the tortious interference cause of action when a party is asserting in good faith a legally protected interest. But, as is clear, the court found that APC’s actions were not designed to protect its security interest in the property as mortgagee, but rather had some other design. Part of this conclusion, however, seems based upon the court’s conclusion that APC’s actions were beyond its legal authority, and this conclusion seems to be very questionable.

Comment 2: As to its position that the mortgagee acted outside the law in demanding that the tenant pay rents to it when the tenant was not a party to the assignment of rents, the court cites one Vermont case, which holds nothing of the kind. In fact, the editor reviewed the authorities relied upon in that case, and they appear to stand for the proposition that the mortgagee is clearly within its rights in requesting that the tenant pay rents over to the mortgagee following mortgagor default, but that if the tenant refuses to do so, it may be necessary for a court to declare the relationship. This may be a practical requirement with an uncooperative tenant in Vermont, but certainly the Vermont law is that “there’s no harm in asking.”

Comment 3: What troubles the editor is that, despite the adjectives, the court’s real reason for concluding that APC was liable for damages was its conclusion that, absent tenant’s signature on the assignment of rents, APC acted outside of its legal authority. So far as the editor can make out, this conclusion is manifestly incorrect. A second basis for the court’s conclusion is that APC had no reason to be concerned about the tenant’s lease extension, and indeed should have welcomed it. But, assuming, as APC must be allowed to have assumed, that APC would ultimately have to sell the property, and perhaps even to buy it, to preserve its investment in the loan, it doesn’t strike the editor as so unreasonable for APC to want to know about the tenant’s finances, or for it to be concerned about a ninety day termination right in the tenant, or even for APC to be concerned as to whether tenant’s renovations in fact complied with the local building code.

Perhaps the court’s conclusion that APC’s principle, out of his own mouth, admitted that the tactics he was using were not to protect APC’s security but to “pressure a deal” out of Borrower, is the major element making the decision defensible. Clearly, whatever he learned about real estate, this guy didn’t learn much about testifying in court. But of course, we don’t have the exact context in which all this got said. In light of the court’s other conclusions, we might want to be cautious about crediting the court’s interpretation of the testimony. But that’s not real estate law, so we have no evidence that the court lacked competency in this area [in fact, apparently the judge participated in the writing of the Vermont evidence code - obviously at the expense of learning much about foreclosure law.]

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